Home Prices Linked to Consumer Confidence and Investment, Economist Says

Downward spiraling home prices affect consumer confidence, says Rajeev Dhawan, director of the Economic Forecasting Center at Georgia State University’s J. Mack Robinson College of Business. Still, deflation and an ensuing double-dip recession can be avoided if home prices don’t fall again, says Dhawan in his quarterly forecast released today.

The word “deflation” is being heard more frequently, he says. That is because of factors such as the slowing of private job creation, yo-yoing retail sales, falling core CPI inflation excluding food and energy costs, and a rapidly falling 10-year bond yield that is now below 3%.

“Consequently, what happens to home prices over the next few months will be critical to the confidence of consumers,” says Dhawan. “It will affect their spending decisions, especially for big ticket items.”

Companies will determine whether or not to ramp up their investment and hiring plans, in response, which will determine potential consumer income growth and the next round of spending, according to the economist.

The importance of home price stability is also evident in that one-third of the CPI Index derives from housing or shelter costs, he says. “If we take shelter costs out of the core, there is no deflation,” So, if home prices plunge again, spending power will be sapped, resulting in further price declines that will show up as deflation, leading to double dip recession, says Dhawan.

However, there is positive news, he says. The growth rate of investment in equipment and software, the precursor of job growth, has been in double digits for the past nine months.

Real GDP growth in 2010 will be 2.8%, decelerating to 1.9 % in 2011 because of a rollback in government spending and subdued consumer spending, researchers at the Economic Forecasting Center project.

In the meantime, consumption growth is expected to remain below par, barely reaching 2.2% in 2012.

Inflation is projected to be 0.8% in the second half of 2010, and 1.3% in 2011, increasing to 2.1% in 2012, according to the Forecasting Center.